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Investing without a deadline

17 May 2018

Dr Peter Brooks, Head of Behavioural Finance, explains why it’s the time you spend invested which will largely determine your return.

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice. Tax rules can change in future. Their effects on you will depend on your individual circumstances.

What you’ll learn:

Why investing early gives you the best chance of success

The problem with doing nothing

The benefits of making regular investments

We will all recall times where, slightly panicked, we make every effort to get something done before an important deadline. Whether that is handing in an important assessment on time, or something more fun like booking a holiday before an enticing offer ends, deadlines are powerful motivators for us all. They nudge us to take action because they trigger loss aversion – our strong desire to avoid losing or missing out on something.

UK tax years provide an important deadline for many investors because annual allowances on ISAs and pensions need to be used before they are lost. In the case of pensions the carry forward of annual allowances means it is any unused allowance from three tax years ago that you are losing. Importantly, it is the use it or lose it nature of annual allowances which prompt many of us into action in the weeks before the tax year ends. You need to keep in mind that ISA and other tax rules may change in the future. Also, the benefits to you of any favourable tax treatment depend on your individual circumstances, which may change over time as well.

In the early part of a tax year there are few, if any, looming deadlines and it is easy to put off making an investment decision. Doing nothing is a comfortable status quo. If you are fortunate enough to benefit from tax advantaged accounts like ISAs and pensions, and have cash to invest now or throughout the year, it can be costly to wait.

Does it really make much difference?

Yes, the difference can be material. Nobody has perfect foresight, so we tend to answer that question by making the case for long-term investing. Stock markets will go up and down each day, but over the long term they have tended to go up more often than they go down. If you have a long enough time horizon, preferably at least five years, and the ability to accept risk, then it is the time you spend invested which will largely determine your return. The earlier you get invested, the sooner to start to earn your investment returns.

It’s important to remember that although staying invested over the long-term gives your money the greatest chance to grow, there are no guarantees; you might still suffer losses no matter how long you invest for. Additionally, past performance is not a reliable indicator of future performance.

A different way of looking at this is to think about what you might be giving up. Ask yourself what you expect your investments to return in the next year. Then ask yourself what return you’d get on your cash while it isn’t invested. If you expect a higher return from investing then the way to maximise your return is to get invested as soon as possible.

What if there is a better opportunity?

The problem with following this rational logic is that our expectations of investment performance are heavily influenced by our past experiences and current headlines. It is easy to search for the news stories which reinforce an expectation of an impending market crash, and the inevitability that there will be a better time to invest. In the absence of the deadline imposed by losing a tax break this can be powerful motivation for doing nothing now.

If you expect a market fall, of course it is the rational decision to wait. However, nobody can tell you with certainty whether any significant fall will happen within the current tax year. Importantly, our experience of working with investors has shown that when a market fall happens and negative sentiment is at its highest; it can be difficult to have the discipline to buy.

Making investing dispassionate

Two frequently used statements are worth keeping in mind. First, that it is the time invested in the market, not timing the market which matters. This calls for a disciplined approach to getting invested. Second, that although tax can be an important consideration it shouldn’t be the primary reason for an investment decision. Taken together, these argue for investing early in the tax year rather than waiting, if you have the cash and time horizon to invest. Without a looming deadline motivating you to get invested, we believe that good investment discipline can help.

Consider using the regular investment service to spread your investments over the year. As markets move your sentiment may shift and setting up a plan of regular investments provides a commitment to getting invested no matter what the markets are doing. This will allow you to put your money to work as soon as possible, and limits the potential that as markets move up and down, you’ll be too fearful to take advantage.

Another reason to get started sooner rather than later is to take advantage of dividend reinvestment. Reinvesting income can be a major factor in long-term returns for investors, as it can be used to buy more shares which will potentially grow in value. In simple terms, your returns also earn returns, which is known as compounding.

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